Wednesday, September 22, 2010

Everybody wants a weak currency

While the logic of having a weak currency to benefit exporters has general acceptance, the reality is that this is a comparative measure - one currency against other currencies and it simply not possible for all countries to have comparatively weak currencies. If one currency falls, others must rise.

In this context, the efforts of central banks to weaken their nations' currencies is getting quite intense. As examples:

1. the US Federal Reserve's asset buying programme has the effect of selling dollars;

2. the European Central Bank's asset buying programme has the effect of selling Euros

3. Japan made a big effort to talk about it's intervention in the currency markets to stem the rise of the yen

4. Brazil and South Korea (among others) have taken action to weaken their local currencies

5. China operates a fixed exchange rate which is widely viewed as making the RMB undervalued.

Not every currency can be weak relative to other currencies. At the moment, the biggest loser in the battle to have a weak currency would appear to be Japan and the biggest winners would appear to be China and some of the major exporters in the Euro zone (e.g. Germany).

Of course a weak currency also has other consequences, including the cost of imports and the impact on inflation.

However, I really have to wonder how it will end when so many major countries are all attempting to have their currencies trade relatively lower than their major trading partners? At the very least, there has to be some basis for arguing that the competition to achieve comparative devaluation of a number of currencies will result in absolute devaluation of paper currencies generally. This would certainly be consistent with the historical track record of paper money (aka fiat currency) depreciating over time. It would also suggest that either inflation or biflation looks more likely than deflation over the longer term.

As an investor, the issue is what are the implications for my portfolio. I continue to believe that cash and low yielding notes and bonds are a poor store of wealth. I have never been a fan of gold (a point on which I concede to being very wrong over the last few years), but do believe that investing in assets which have the potential to appreciate over time at an acceptable rate of return (say a real rate of 3% pa) is critical to long term financial success. From this perspective, competitive devaluation does not change my approach to investments. However, the possibility of seeking greater diversification between asset classes and along geographical lines is something to consider.